NBFCs brace for tough times with debenture reserve

Draconian move: Today is last day for bond raisers to set aside 15% of debentures falling due this fiscal in liquid instruments

Various trade and industry bodies are lobbying hard with the Ministry of Company Affairs (MCA) to withdraw the draconian debenture redemption reserve (DRR) which came into effect on April 1 and is threatening to wipe out liquidity from the debt market.

Wednesday (April 30) is the last day to set aside 15% of debentures falling due in fiscal 2015. These funds are to be invested in liquid instruments like lower-yielding government bonds, certificates of deposits and bank deposits that will increase non banking finance companies' (NBFC) cost of funds.

Of all the fund raisers, NBFCs are the most hit as cash is their raw material. They rely heavily on raising funds through debentures for onward lending or funding assets.

The new norm also mandates provisioning of 50% of redemption value.

Power and infrastructure financing companies are hit the most by this norm as they are leveraged five times their net worth – three times from debt and two from banks. "A DRR of 50% works out to roughly 1.5 times the net worth," said a senior finance executive at a bank.

The new norm has included private placement of debentures too under the DRR guidelines. "This effectively brings down the profitability of NBFCs to pittance, and all at the cost of investors of debts," said a finance head at an NBFC.

"There is no clarity on the utilisation of reserves. A company cannot declare dividends out of reserves," said D K Vyas, CEO at Srei BNP Paribas.

NBFCs access to banking system has been limited hence they raise funds through debentures for working capital. If the debentures are long term in nature, they are in a position to pay from profits, however, when debentures are of shorter tenures, they need to extend financing working capital through debentures and hence creating reserves out of that becomes financially unviable.

"We already provide for depreciation, interest and dividends where the cash is still in the system. These serve the purpose for which DRR is intended. What is the need to create extra provisions in DRR?" asked a director at a mid-sized NBFC.

"How am I supposed to pay dividends to shareholders when there is nothing left in the kitty?" he asked. "The least MCA could have done was to consult the Reserve Bank instead of such high-handed diktats.

Our bureaucrats sure have the power to convert profits into losses," he said.

According to industry sources, government officials refused to give them a hearing as they were "busy" with the ongoing elections.

In fiscal 2014, corporates have raised Rs 2.55 lakh crore worth of debentures through private placements and this is in addition to Rs 42,383 crore raised through public issue of corporate bonds.

NBFCs have been crying foul over the MCA's ill-planned move, which in its bid to secure the financial markets is actually throttling businesses.

While the finance ministry has been striving for a vibrant debt market, the new DRR norms only negate such initiatives with a probable drop in new issues.